Question

.The firm's noncallable bonds mature in 15 years, have 7.50% annual coupon, a par value $1,000, and a market price of $1,075. The company’s tax rate is 40%. The risk-free rate is 2.50%, the market risk premium is 6.50%, and the stock’s beta is 1.30. The target capital structure consists of 35% debt, 10% preferred stock, and the balance is common equity. The preferred stock currently trades at $50 and has a dividend of $4 per share.

What is the cost of debt?

What is the cost of equity?

What is the WACC?

Assume that the risk-free rate is 3.5% and the expected return on the market is 9%.

      What is the required rate of return on a stock with a beta of 1.2?

Answer 1

What is the cost of debt?
Using financial calculator
N=15
PMT=7.5%*1000
FV=1000
PV=-1075
CPT I/Y=6.6925%

Pretax cost=6.6925%

After tax cost=6.6925%*(1-40%)=4.0155%

What is the cost of equity?

=risk free rate+beta*market risk premium

=2.50%+1.30*6.50%
=10.9500%

What is the WACC?

=35%*4.0155%+10%*(4/50)+55%*10.95%
=8.2279%

Assume that the risk-free rate is 3.5% and the expected return on the market is 9%.

What is the required rate of return on a stock with a beta of 1.2?

=risk free rate+beta*(market return-risk free rate)

=3.5%+1.2*(9%-3.5%)

=10.10%